Stock-Based Compensation

Stock-based compensation is measured at the grant date based on the grant-date fair value of the awards ultimately expected to vest, and is recognized as an expense on a straight-line basis over the vesting period, which is generally five years for stock options and three years for restricted stock units. In addition to restricted stock units with a service condition, we grant restricted stock units with both a market condition and a service condition (market-based restricted stock units). The number of shares of the Company's common stock to be issued upon vesting of market-based restricted stock units will range from 0% to 200% of the target amount, based on the comparison of the Company's total shareholder return (TSR) to the median TSR of a specified peer group over a three-year period. TSR is a measure of stock price appreciation plus any dividends paid during the performance period. Determining the amount of stock-based compensation to be recorded for stock options and market-based restricted stock units requires the Company to develop estimates to calculate the grant-date fair value of awards.

Grant-Date Fair Value — The Company uses the Black-Scholes valuation model to calculate the grant-date fair value of stock option awards and the Monte Carlo simulation model to calculate the grant-date fair value of market-based restricted stock units. The use of these valuation models requires the Company to make estimates and assumptions, such as expected volatility, expected term, risk-free interest rate, expected dividend yield and forfeiture rates. The grant-date fair value of restricted stock units with only a service condition represents the value of the Company’s common stock on the date of grant, reduced by the present value of dividends expected to be paid on the Company’s common stock prior to vesting.

Information pertaining to the Company’s stock option awards and the related estimated weighted-average assumptions to calculate the fair value of stock options using the Black-Scholes valuation model granted during the three- and six-month periods ended May 3, 2014 and May 4, 2013 are as follows:



	Three Months Ended						Six Months Ended
Stock Options	May 3, 2014			May 4, 2013			May 3, 2014			May 4, 2013
Options granted (in thousands)	2,094			2,266			2,110			2,286
Weighted-average exercise price		$51.74			$46.47			$51.72			$46.41
Weighted-average grant-date fair value		$9.00			$7.36			$8.99			$7.35
Assumptions:
Weighted-average expected volatility	24.9		%	24.6		%	24.9		%	24.6		%
Weighted-average expected term (in years)	5.3			5.4			5.3			5.4
Weighted-average risk-free interest rate	1.7		%	1.0		%	1.7		%	1.0		%
Weighted-average expected dividend yield	2.9		%	2.9		%	2.9		%	2.9		%

The Monte Carlo simulation model utilizes multiple input variables that determine the probability of satisfying the performance conditions stipulated in the award grant and calculates the fair market value for the market-based restricted stock units granted. The Monte Carlo simulation model also uses stock price volatility and other variables to estimate the probability of satisfying the performance conditions, including the possibility that the market condition may not be satisfied, and the resulting fair value of the award. Information pertaining to the Company’s market-based restricted stock units and the related estimated assumptions used to calculate the fair value of market-based restricted stock units granted during the three- and six-month periods ended May 3, 2014 using the Monte Carlo simulation model are as follows:



	Three and Six Months Ended
Market-based Restricted Stock Units	May 3, 2014
Units granted (in thousands)	86
Grant-date fair value		$50.79
Assumptions:
Historical stock price volatility	23.2		%
Risk-free interest rate	0.8		%
Expected dividend yield	2.8		%

Market-based restricted stock units were not granted during the three- and six-month periods ended May 4, 2013.

Expected volatility — The Company is responsible for estimating volatility and has considered a number of factors, including third-party estimates. The Company currently believes that the exclusive use of implied volatility results in the best estimate of the grant-date fair value of employee stock options because it reflects the market’s current expectations of future volatility. In evaluating the appropriateness of exclusively relying on implied volatility, the Company concluded that: (1) options in the Company’s common stock are actively traded with sufficient volume on several exchanges; (2) the market prices of both the traded options and the underlying shares are measured at a similar point in time to each other and on a date close to the grant date of the employee share options; (3) the traded options have exercise prices that are both near-the-money and close to the exercise price of the employee share options; and (4) the remaining maturities of the traded options used to estimate volatility are at least one year.

Expected term — The Company uses historical employee exercise and option expiration data to estimate the expected term assumption for the Black-Scholes grant-date valuation. The Company believes that this historical data is currently the best estimate of the expected term of a new option, and that generally its employees exhibit similar exercise behavior.

Risk-free interest rate — The yield on zero-coupon U.S. Treasury securities for a period that is commensurate with the expected term assumption is used as the risk-free interest rate.

Expected dividend yield — Expected dividend yield is calculated by annualizing the cash dividend declared by the Company’s Board of Directors for the current quarter and dividing that result by the closing stock price on the date of grant. Until such time as the Company’s Board of Directors declares a cash dividend for an amount that is different from the current quarter’s cash dividend, the current dividend will be used in deriving this assumption. Cash dividends are not paid on options, restricted stock or restricted stock units.

Stock-Based Compensation Expense

The amount of stock-based compensation expense recognized during a period is based on the value of the awards that are ultimately expected to vest. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The term “forfeitures” is distinct from “cancellations” or “expirations” and represents only the unvested portion of the surrendered stock-based award. Based on an analysis of its historical forfeitures, the Company has applied an annual forfeiture rate of 4.4% to all unvested stock-based awards as of May 3, 2014. The rate of 4.4% represents the portion that is expected to be forfeited each year over the vesting period. This analysis will be re-evaluated quarterly and the forfeiture rate will be adjusted as necessary. Ultimately, the actual expense recognized over the vesting period will only be for those options that vest.

Additional paid-in-capital (APIC) Pool

The APIC pool represents the excess tax benefits related to share-based compensation that are available to absorb future tax deficiencies. If the amount of future tax deficiencies is greater than the available APIC pool, the Company records the excess as income tax expense in its condensed consolidated statements of income. During the three- and six-month periods ended May 3, 2014 and May 4, 2013, the Company had available APIC pool to absorb tax deficiencies recorded and as a result, these deficiencies did not affect its results of operations.

Stock-Based Compensation Activity

A summary of the activity under the Company’s stock option plans as of May 3, 2014 and changes during the three- and six-month periods then ended is presented below:



Activity during the Three Months Ended May 3, 2014	Options Outstanding (in thousands)		Weighted- Average Exercise Price Per Share		Weighted- Average Remaining Contractual Term in Years	Aggregate Intrinsic Value
Options outstanding February 1, 2014	16,362			$33.79
Options granted	2,094			$51.74
Options exercised	(2,038	)		$30.84
Options forfeited	(93	)		$41.02
Options expired	(1	)		$29.03
Options outstanding at May 3, 2014	16,324			$36.42	5.9		$245,430
Options exercisable at May 3, 2014	10,057			$31.09	4.2		$204,304
Options vested or expected to vest at May 3, 2014 (1)	15,750			$36.05	5.8		$242,568


(1)	In addition to the vested options, the Company expects a portion of the unvested options to vest at some point in the future. The number of options expected to vest is calculated by applying an estimated forfeiture rate to the unvested options.




Activity during the Six Months Ended May 3, 2014	Options Outstanding (in thousands)		Weighted- Average Exercise Price Per Share
Options outstanding November 2, 2013	18,992			$33.56
Options granted	2,110			$51.72
Options exercised	(4,545	)		$31.35
Options forfeited	(208	)		$40.89
Options expired	(25	)		$45.24
Options outstanding at May 3, 2014	16,324			$36.42

During the three and six months ended May 3, 2014, the total intrinsic value of options exercised (i.e., the difference between the market price at exercise and the price paid by the employee to exercise the options) was $42.9 million and $87.8 million, respectively, and the total amount of proceeds received by the Company from the exercise of these options was $62.9 million and $142.5 million, respectively.

During the three and six months ended May 4, 2013, the total intrinsic value of options exercised (i.e., the difference between the market price at exercise and the price paid by the employee to exercise the options) was $31.2 million and $83.2 million, respectively, and the total amount of proceeds received by the Company from the exercise of these options was $62.2 million and $176.0 million, respectively.

A summary of the Company’s restricted stock unit award activity as of May 3, 2014 and changes during the three- and six-month periods then ended is presented below:



Activity during the Three Months Ended May 3, 2014	Restricted Stock Units Outstanding (in thousands)		Weighted- Average Grant- Date Fair Value Per Share
Restricted stock units outstanding at February 1, 2014	1,695			$39.00
Units granted	814			$47.78
Restrictions lapsed	(34	)		$37.20
Forfeited	(26	)		$38.98
Restricted stock units outstanding at May 3, 2014	2,449			$41.95




Activity during the Six Months Ended May 3, 2014	Restricted Stock Units Outstanding (in thousands)		Weighted- Average Grant- Date Fair Value Per Share
Restricted stock units outstanding at November 2, 2013	2,493			$37.62
Units granted	838			$47.75
Restrictions lapsed	(818	)		$34.96
Forfeited	(64	)		$38.69
Restricted stock units outstanding at May 3, 2014	2,449			$41.95

As of May 3, 2014, there was $115.9 million of total unrecognized compensation cost related to unvested share-based awards comprised of stock options, and restricted stock units. That cost is expected to be recognized over a weighted-average period of 1.6 years. The total grant-date fair value of shares that vested during the three and six months ended May 3, 2014 was approximately $12.7 million and $52.2 million, respectively. The total grant-date fair value of shares that vested during the three and six months ended May 4, 2013 was approximately $11.9 million and $62.1 million, respectively.